Infrastructure: Real Assets and Real Returns

Published date01 September 2014
Date01 September 2014
European Financial Management, Vol. 20, No. 4, 2014, 802–824
doi: 10.1111/j.1468-036X.2012.00650.x
Infrastructure: Real Assets and Real
Ron Bird
Paul Woolley Centre, University of Technology, Sydney, PO Box 123 Broadway NSW 2007, Australia
Harry Liem
University of Technology, Sydney, PO Box 123 Broadway NSW 2007, Australia
Susan Thorp
University of Technology, Sydney, PO Box 123 Broadway NSW 2007, Australia
Little empirical work has been done on infrastructure as an asset class despite
increased allocations by institutional investors. We build a robust factor model of
infrastructurereturns using US and Australian infrastructureand utility data to test
manager claims that infrastructure investments offer benefits via a combination of
monopolistic and defensive assets. We find evidence of excess returns and inflation
hedging, but not of defensive characteristics. We compare option-based models
designed to replicate infrastructure asset returns, and identify the regulatory risk
premium. A combination of inflation linked bonds and covered call strategies
results in improved defensive and inflation hedging characteristics.
Keywords: inflation hedging,regulatory risk premium,infrastructure assets.
JEL classification: G12, G14
The authors wish to acknowledge the generous support of the Paul Woolley Centre at
the University of Technology, Sydney (UTS). In addition, Thorp acknowledges Australian
Research Council (ARC) DP 0877219. The Chair of Finance and Superannuation at UTS
receives support from the Sydney Financial Forum (Colonial First State Global Asset
Management), the NSW Government, the Association of Superannuation Funds of Australia
(ASFA), the Industry Superannuation Network (ISN), and the Paul Woolley Centre, UTS.
The authors also wish to thank John Doukas, two anonymous referees, and attendees at the
2011 Paul Woolley Conference in Sydney for their valuable comments and suggestions.
2012 Blackwell Publishing Ltd
© 2012 John Wiley & Sons Ltd
Infrastructure 803
© 2012 John Wiley & Sons Ltd
1. Introduction
Pension funds around the world have been investing in infrastructure with the aim of
providing better long duration, real (inflation adjusted) retirement benefits to members.
While infrastructure has been seen as a suitable institutional investment in Australia,
Canada and the UK since the 1990s, it has only recently increased in popularity in the
USA and, unlike hedge funds or private equity, has not been the focus of much academic
research, partly because of limited data (Dechant et al., 2010; Martin, 2010; Newell and
Peng, 2008).
In this paper we define infrastructure as encompassing the utility sector (power
generation and distribution) as well as the ‘pure’ infrastructure sector (toll roads, com-
munications and airports). Institutional investors most commonly delegate infrastructure
investment to managers but may also undertake direct investment (Inderst, 2009).1We
consider investment in both listed and unlisted Australian infrastructure assets, either
directly or through managed funds. Outside of Australia, where less data is available,we
focus on the listed infrastructure markets.
Initially researchers viewed infrastructure as having characteristics akin to real estate:
a long life cycle, heterogeneity, illiquidity and inflation hedging ability (Dechant et al .,
2010; Newell and Peng, 2007, 2008). However, a defining feature of the sector is the
prevalence of ‘natural monopolies’ in the provision of essential services (such as energy
or water) and of economies of scale created bylarge distribution networks (Dimasi, 2010).
Researchers now concur that infrastructure is a distinct asset class having oligopolistic
or monopolistic characteristics, because of restrictions on ownership and on the uses to
which infrastructure can be put. Natural monopolies and industries enjoying economies
of scale are often regulated by government restrictions on prices, returns, output levels
or barriers to entry. Consequently, infrastructure investments require compensation for
regulatory risk. In many countries, infrastructure consists of mature utilities, increasingly
facing deregulation and privatisation (Inderst, 2009). As a result, the ability to deliver
superior performance may diminish as the industry matures (deregulates).
We makethe following three contributions to literature. First, we suggest style factors
common to both USA and Australian infrastructure investments. We extend our analysis
by applying an asymmetric GARCH model to take account of observed volatility
clustering in excess returns and we test both the defensive and the inflation hedging
ability of the asset class. We find evidence of excess returns and inflation hedging
features in infrastructure investments in the USA and Australia. While we do find some
desirable characteristics, we caution against sample size and time period biases given
the limitations of our data set.
Second, we test the defensive ability of infrastructure investments during equity down
markets. We find no evidence of defensive characteristics. Despite claims that it is a
defensive sector, Australian listed infrastructure funds performed very poorly during the
Global Financial Crisis.2
1Infrastructure investment methods are described in detail in the appendix.
2Notably, large infrastructure f irms such as Macquarie and Babcock & Brown werecriticised
for ‘asset gathering’ using leverage, thereby generating transaction, advisory, base and
performance fees for the parent company. In March 2009, Babcock and Brown was placed
into voluntary administration due to its over-reliance on short-term debt while Macquarie
restructured and survived as Intoll Group.

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